The Echo is EquaTerra’s quarterly wrap-up and analysis of events and trends in the global business and information technology (IT) services markets. The Echo complements and extends the EquaTerra quarterly global Pulse surveys. The Echo draws from findings from EquaTerra’s own research and client engagements as well as newly released research and commentary from select consultancies, research firms, equity analysts and news agencies. Past editions of the Echo and associated podcast are available in the EquaTerra research library.

Market Overview

Deal flow remained choppy in 2Q10 for third-party business and IT services, including business process and IT outsourcing (BPO/ITO), according to EquaTerra advisors and third-party service providers polled as part of EquaTerra’s global quarterly Pulse survey and according others that track business and IT services market trends and developments. .

While inherent outsourcing demand remains positive and is growing overall, many buyers remain cautious, risk averse and indecisive when pursuing change initiatives. Use of internal resources and pursuit of internal process improvement efforts continue to receive favorable preference as a means to reduce or avoid the use of outside services. Economic conditions continue to heavily impact buyer usage and preferences for third-party services and the manner in which they consume these services.

Cloud computing models, especially software as a service (SaaS), are generating significant interest among buyers both as a complement to and in lieu of traditional outsourcing. Most buyers today, however, are still testing the waters when it comes to cloud computing investments. There are clear long-term opportunities for legacy and emerging third-party cloud service providers to make money off buyers’ cloud computing initiatives. It is still unclear which providers will benefit the most and how much these new revenue streams will offset declining traditional systems integration work and potentially the loss of traditional outsourcing business. Service providers remain focused on growing business in existing accounts over pursuing new deals.

“Worldwide IT spending is forecast to total $3.350 trillion in 2010, an increase of 3.9 percent from 2009 spending of $3.225 trillion, according to the latest outlook by Gartner, Inc. Gartner has lowered its outlook for the IT industry from the first quarter of this year when it forecast worldwide IT spending to grow 5.3 percent, primarily due to the devaluation of the euro versus the U.S. dollar since the beginning of the year.”

“’Our latest IT spending forecast reflects the fact that the global economic outlook is stable but vulnerable to shocks in key regions and industries, which means that IT spending decisions are still scrutinized for value,’ Mr. Richard Gordon of Gartner said.”

“Worldwide cloud services revenue is forecast to reach $68.3 billion in 2010, a 16.6 percent increase from 2009 revenue of $58.6 billion, according to Gartner, Inc. The industry is poised for strong growth through 2014, when worldwide cloud services revenue is projected to reach $148.8 billion… Gartner estimates that, over the course of the next five years, enterprises will spend $112 billion cumulatively on software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS), combined.”

"’Many enterprises may be examining cloud computing and cloud services, but are far from convinced that it is appropriate for their requirements,’ said Ben Pring, research vice president at Gartner. ‘We expect that this will be a significant opportunity for existing IT services players to evolve their current offerings — such as outsourcing, system integration, development, etc. — to become cloud-enabled and try to combine the best of the two worlds, namely traditional IT services and cloud computing.’"

New EquaTerra Research Alliance: On May 6, 2010 EquaTerra announced a research alliance with Horses for Sources (HfS Research, Ltd), a social networking community and advisory analyst firm, to bring “actionable intelligence” into the sourcing marketplace. HfS Research was founded by Phil Fersht, blogger extraordinaire and one of the top market research analysts covering business and IT services. Phil and the HfS research team are regular contributors and participants in the EquaTerra Echo and other EquaTerra research.

• Half of today's enterprise buyers are disappointed with the innovation they have currently achieved

• The potential to achieve innovation across many core business processes is huge. This was notably cited in industry-specific process and analytics areas, in addition to some maturing BPO domains, namely procure-to-pay, supply chain and recruitment

So why aren't half of today's enterprise buyers achieving innovation? When we asked those executives with significant influence over BPO decisions their prime concerns for failing to achieve innovation in BPO, they cited the following reasons:

It is abundantly clear that enterprise buyers recognize that the blame lies a lot more in their camp than their provider's, with well over a third citing poor change management and communications as a great concern, coupled with the fact that their current governance team has little juice internally to drive an innovation agenda. If they were going to blame primarily their provider's lack of innovation prowess, much more than a fifth of buyers would have cited "the wrong composition of skills among their governance team and the provider's relationship team" as a major concern.

In the next installment of this innovation saga, we reveal what buyers are planning to do to achieve innovation. Here are a few clear areas they can work on:

• Create an aggressive innovation agenda and a plan to keep that agenda fresh over time

• Communicate this innovation agenda to both governance and provider teams

“We are cognizant of the fact that the shift to ‘the cloud’ will take time and that the investment in legacy IT is so large that the impact of this shift on incumbent vendors could be quite small for some time. However, it is pretty clear which way the wind is blowing. We recognize that the excitement level about ‘the cloud’ is reaching record levels among investors, technology vendors and the media, and it seems to us that we are either at the peak of inflated expectations or at the cusp of a very important technology shift. We believe the latter and an anecdote we picked up yesterday [at a Cloud Computing conference in San Francisco hosted by the tech blog and research firm GigaOM] from an IT executive at Intel supports this view. Intel has 6,000 employees, 100,000 servers and 95 data centers in its IT department and is one of the most innovative companies in history. Yet, only in late 2009 did Intel launch a concerted internal shift to ‘the cloud’ in an effort to cut costs and drive efficiency gains. We may barely be out of the first inning of this transformation.”

Keirstead on Impact of SaaS on traditional systems integration service providers:

“Most of our sources believe that the SaaS model permanently diminishes the need for on-site systems integration and implementation work and hence that the SaaS model could ultimately be unfriendly to traditional third party systems integrators. In the near term, however, there are certainly some facts working in traditional providers’ favor. To begin, few large enterprises are shifting their core ERP and other mission-critical systems to ‘the cloud’ and the vast majority of software budgets are still being spent on on-premises licenses. In other words, the old stuff is not going away anytime soon. In the interim, many large enterprises are cutting costs by rationalizing their existing applications footprint (i.e., taking the number of instances of SAP financials from 20 worldwide to just three) and are hosting these centralized systems internally in ‘private’ clouds. This could create work for traditional systems integrators.”

Keirstead on BPO Meets the Cloud – "Business Process-as-a-Service":

“Until recently we've heard very little about how the cloud computing model is impacting the BPO market but in the last few months some industry analysts have begun addressing the issue. The idea is that BPO platforms can be hosted and effectively ‘multi-tenant’ and those clients will be able to acquire claims processing, accounting or other services on a pay-as-you-go or per-transaction basis instead of having a long-term BPO contract priced on a per-employee basis and with minimum annual revenue commitments. This model is clearly in the very early stages and, in our view, it is having little if any impact on traditional BPO providers. It is also not obvious to us how a transition to a ‘pay-as-you-go’ model would be a positive for the onshore and offshore BPO vendors. While it may provide a new way for BPO vendors to leverage their platforms and scale, a pay-as-you-go model sounds a lot like pricing pressure in disguise.”

Accenture (ACN): released 3Q10 earnings on June 24, 2010. 2Q10 net revenue was $5.6B, an increase of 8% Y/Y and diluted earnings per share were $0.73, up 5% Y/Y. New bookings for the quarter were $6.4B, with consulting bookings of $3.2B and outsourcing bookings of $3.25B, bringing total new bookings for the 1H FY10 to $18.5B. See note above from equity analyst Karl Keirstead on the potential impact of cloud on the service business of firms like Accenture.

Also, according to Keirstead “The numbers out of Accenture, IBM, HP, CSC and Cap Gemini suggest that the overall IT services industry was flat year over year in 1H10, a disappointing recovery trajectory, and the volume surge reported by the low-cost India-based firms such as Cognizant and Infosys may be more a function of share gains than an overall IT spending recovery.”

Phil Fersht elaborated on this point, “The Indian pure plays have exploited the recession extremely well to muscle in on the Western providers’ business, especially in large enterprises. However, much of these gains are as a result of winning a lot of the less-complex application work, as opposed to more complex IT services and consulting. As the market levels out over the next year, the next battleground will be for services which involve more complex business/IT alignment and BPO which necessitates real process knowledge and domain acumen. Whether the Indian pure plays have invested sufficiently in the right skills to move up the value chain remains to be seen.”

Capgemini (trades in Europe):: released 1Q10 earnings on May 6, 2010. 1Q10 revenue was €2.05B, “practically unchanged” Q/Q and up 7% Y/Y. Consulting services revenues were up 3% and outsourcing revenues down 3% in the quarter. Total bookings for the quarter were €2.1B, in line with the firm’s forecasts. Paul Hermelin, Chief Executive Officer of Capgemini Group stated, “The global economic crisis impacted our industry late on, but signs of a recovery in corporate investment are multiplying. Thanks to the five global service lines set up at the end of 2009, we are ideally placed to benefit from this recovery and enjoy a return to growth in the second half.”

Cognizant (CTSH): released 1Q10 earnings on May 4, 2010. 1Q10 revenue increased to $960M, up 29% Y/Y. Diluted EPS on a GAAP basis was $.49, compared to $.38 in the previous year. The firm projects FY10 revenue to be at least $4.1B, up at least 25% Y/Y and up from last quarter’s estimates of $3.9B. “Against the backdrop of an improving macroeconomic environment, our first quarter results confirm that our strategy of reinvestment continues to provide the platform for industry-leading growth," said Francisco D'Souza, president and CEO of Cognizant. "The opportunities for further penetration within our core services market remain significant.”

CSC (CSC): released 4Q10 earnings on May 20, 2010. Revenue was $4.2B and fully diluted earnings per share (EPS) of $1.66 compared to 4Q09 revenue of $4.1B and EPS of $2.51 (includes a one $1.11 adjustment). New business awards were $4.3B for the quarter and $19.2B for the fiscal year, an increase of 18.5% over the previous year. “Our fourth quarter revenue reflects a sequential increase of 7%, and that, coupled with the $19.2 billion of new business awards, positions us for a return to growth in Fiscal Year 2011,” said CSC Chairman and Chief Executive Officer Michael Laphen. “As the world economies gradually improve, our financial strength, market position, and innovative solutions will stimulate expansion across our three lines of business.”

HCL Technologies (trades in India): released 3Q10 earnings on April 21, 2010. Revenue was $685M, up 5% Q/Q and 21% Y/Y. EBIT was $111M, up 20% Y/Y and net income was $77M, up 78% Y/Y. According to Dow Jones, “The quarter was also marked by 13 new deals, when the company added 39 clients. It added 3,152 employees on a net basis in its information technology services division in the just-ended quarter, taking its staff strength to 58,129 at the end of March.”

HP (HPQ): released 2Q10 earnings on May 18, 2010. Services revenue increased 2% to $8.7B. Infrastructure Technology Outsourcing revenue increased 6% to $4.1B. Technology Services and Business Process Outsourcing revenues were flat Y/Y at approximately $2.4B and $725M respectively. Application Services revenue was down 2% Y/Y to approximately of $1.4 billion. Services operating profit was $1.4 billion, or 15.9% of revenue, up from $1.2 billion, or 13.8% of revenue, in the prior-year period.

IBM (IBM): released 2Q10 earnings on June 19, 2010. Total Global Services revenues increased 3 percent to $10.2B. Global Technology Services segment revenues increased 1% (flat, adjusting for currency) to $9.2 billion. Global Business Services segment revenues were up 3% at $4.5 billion. IBM signed services contracts totaling $12.3 billion, at actual rates, a decrease of 12 percent, including 13 contracts greater than $100 million. Total outsourcing services contracts (GTS Outsourcing and Application Management) decreased 19 percent to $6.5B and Transactional services (consulting, IT services, systems integration) signings were down 3% to $5.8B. According to Karl Keirstead, “We conclude that the 2Q10 performance of IBM's services business could further cloud if not weaken the Street's 2H10 recovery thesis for this segment. In our judgment, the overall IT services sector is suffering from a tepid recovery and the shift to offshore (primarily India-based) delivery is the key investment theme worth playing.”

Infosys (INFY): released 1Q11 earnings on July 13, 2010. 1Q11 revenue was $1.36B, up 5% Q/Q and 21% Y/Y. Net income for 1Q11 was $326M, down 6% Q/Q and up 4% Y/Y and 38 new clients were added. “While the global economic environment remains uncertain, we continue to see greater demand for services from our clients,” said S. Gopalakrishnan, CEO and Managing Director. “The challenge for the industry is to enhance the investment to grow the business, given the uncertainty in the environment.”

Tata Consultancy Services (BSE:TCS): released 1Q11 earnings on July 15, 2010. 1Q11 revenue was $1.8B, up 6% Q/Q and up 21% Y/Y, quarterly operating profit was $487M, up 5.1% Q/Q and 32.5% Y/Y, 1Q11 EPS were $.21, and 36 new clients were added. Chief Executive Officer and Managing Director, N Chandrasekaran said: "While we remain alert about changing macro dynamics in many markets, our customer-centric business model is very relevant and helps us participate in the ongoing recovery."

Wipro (WIT): released 1Q11 earnings on July 23, 2010. 1Q11 IT services revenues were $1.2B up 4% Q/Q and 17% Y/Y and net income was $284M up 31% Y/Y and IT Services added 21 new clients in the quarter. Azim Premji, chairman of Wipro, commenting on the results said, “We are seeing strong demand environment across our industry verticals despite macro challenges. We added the highest number of billable employees ever, in this quarter. Our guidance reflects this momentum – for the quarter ended September 30, 2010, we expect revenues from our IT Services business to be in the range of $1,253 million to $1,277 million, a sequential increase of 4.1% to 6.1%.”

A growing question in the market for third-party business and IT services is whether the second straight quarter of unexpected slower growth is an aberration, a residual impact of the hangover from the bad economic times of 2008-2009, or the early signs of a more fundamental shift in buyer sourcing preferences. It is clear that long term SaaS and BPaaS models will lead to a permanent decline in the use of third-party systems integration and implementations services. To most involved - except larger providers of these services - this is a good thing given the mixed track record of under-fulfilled expectations and over-budget costs these efforts have entailed.

The situation with ITO and BPO is more complex. This market has for some time been moving beyond the legacy model of taking over problematic buyer assets, processes and resources and hoping to improve them over time (“your mess for less”). Buyers “plugging into” standardized best practice service offerings from third-party providers (i.e., ADP payroll on a grander scale) has long been the industry mantra and is now becoming more often an industry reality. Cloud services, whether from upstart or legacy software and service providers, will further enable this. The ultimate winners on the provider side will be those firms that can combine the best of legacy software and outsourcing models with new capabilities enable via the cloud.

This is clearly a long-term proposition for providers and even more so for buyers. Larger buyer organizations have significant sunk costs in existing IT and business process systems and resources. Moving away from them to a cloud model is an incremental process that will often prove as painful as moving to commercial ERP platforms and global service delivery models. As with many things, the winners – or those organizations that can exploit new software and service delivery capabilities to the greatest extent – are those firms that excel at execution of a realistic, yet appropriately aggressive service delivery strategy. So while it’s exciting to ponder the future wonders of cloud computing, those buyers that are developing an overall strategy and are also in the weeds of when, where and how cloud services can truly create a competitive advantage are in the right place at this time in the evolutionary cycle.

Lastly, it stands to reason that buyers today are spending more time looking inward for the resources and skills to address their most pressing business problems. This is, however, a cyclical and short term phenomenon. It is a function of operating under more cautious and prudent market conditions and recognition that some of the sourcing efforts undertaken over the past few years are unpalatable in today’s more risk averse environment. Longer term, however, most western organizations are operating in an environment of scarce and expensive skills, aging workforces, rapidly advancing technologies and, perhaps most importantly, increasingly strong global competition. These collective market trends will continue to drive increased specialization and increased use of third-party services and supporting technology solutions, albeit ideally in ways that are easier to deploy and more successful in their usage.

About EquaTerraEquaTerra sourcing advisors help clients achieve sustainable value in their IT and business processes. Our advisors average more than 20 years of industry experience and have supported more than 2,000 transformation and outsourcing projects across more than 60 countries. Supporting clients throughout the Americas, Europe, Middle East, Africa and Asia Pacific, we have deep functional knowledge in Finance and Accounting, HR, IT, Procurement, Real Estate and Facilities Management and other critical business processes. EquaTerra helps clients achieve significant cost savings and process improvement with internal transformation, shared services and outsourcing solutions. For more information, please contact Lee Ann Moore at +1 713 669 9292; www.equaterra.com.